Against Borrowing in Providence or Anywhere

In his Saturday column, Ted Nesi makes a point that I’d been thinking about as the week came to a close, related to a proposed $40 million infrastructure bond in Providence:

Governments should borrow to fund long-term infrastructure projects that have a higher rate of return than the interest on the bonds, but [in Providence’s past] bond money was used to pay a principal’s salary and develop a restaurant. Buddy Cianci, apparently confusing borrowed money with free money, told Stycos: “This way, we can make the improvements and the tax rate doesn’t go up.” Cianci left off the crucial word “now” — because the tax rate certainly will go up eventually if the projects aren’t ones that will boost the city economy and help offset the interest costs. Taveras would do well to burnish his reformer credentials further by finding a new, transparent way to allocate bond money if voters approve the proposal in November.

In theory, Ted’s argument definitely applies. One clarification I would make, first, is that one can’t forget the actual cost of the work. The “higher rate of return,” as Ted puts it, can offset the interest, but one suspects that new streets and sidewalks will require replacement well before their incremental benefit has compensated for the whole $40 million plus interest.

That said, suppose an accurate projection finds that improved pavement would increase city revenue — through increased commerce, property values, and so on — by three percent. In such a case, even if the interest paid on the bonds were exactly the same, the city might as well borrow the money rather than save it up over the same period of time and then do the work. Residents and visitors would gain the benefit of tomorrow’s new sidewalks, today.

There are good reasons to resist that argument, both in practical and in theoretical terms.

On the practical end, there’s simply no way to know what the return will be on new infrastructure. We’re not even talking something as straightforward as investment in a start-up company. Returns on infrastructure investments are indirect, almost an investment in a possible investment in a business that might never happen.

Moreover, infrastructure entails more than roads and walkways. Sewer, traffic signals, signage, and more — all of these things present exactly the same opportunity for “return” as does the pavement on which pedestrians walk, perhaps more. Borrowing for all of them would begin to look like using debt as an operating budget, not as a tool for discrete projects, and projections of value are notoriously optimistic.

That leads to the theoretical point: Ted rightly speaks against using debt to pay salaries, but money is fungible. In other words, taking the pressure off the current budget by borrowing money for infrastructure inevitably relieves pressure on employee raises and officials’ pet projects. The sidewalks need to be redone; whether the city redoes them by slicing resources from other parts of the budget and borrowing to cover those or borrows the money directly for the sidewalks and keeps the other expenditures whole is a matter of paper accounting.

The difference, ultimately, is one of salesmanship. The people of Providence might consent to borrowing money for the pathways they traverse every day, but they wouldn’t do so for $40 million in other, more debatable areas of city spending.

The only real argument for using debt to accomplish the fundamentals that really ought to be the first focus of municipal officials is that it creates a dedicated fund that is at least somewhat rigid. Money borrowed to pay for sidewalks is more likely to go to that purpose than a percentage of property taxes intended for the same line item.

Such points, though, constitute less an argument for borrowing than one against the practices that voters currently tolerate. Yes, the degree of transparency and honesty in government is important, but until we acknowledge that the system is corrupt at the most basic level of its practices, our hole is only going to expand and deepen.

(Note: edited at 7:48 a.m., 7/30/2012, to clarify that the bond is for roads and sidewalks.)

There really isn't a good reason to use bond money to fix sidewalks. Sidewalk repair is an ongoing expense — you can expect a certain number of sidewalks to need repair in a given year, and adequate money should be allocated for that annually. To use bond money means that future taxpayers years from now could be still paying off debt used to repair sidewalks for past taxpayers, while their sidewalks fall into disrepair. That's just inter-generational theft.

Trying to see what the long-term payoff will be is useful, but it is also difficult and it confuses the issue. One-time expenditures should be payed off with debt with a maturity of equal length of the expected life of whatever it is you are paying for. Debt shouldn't be used for anything else. A small town could use five-year bonds to pay for a police car, for instance, but a city might be buying a few new police cars every year, so it would be improper to use any debt at all.

You point about the fungibility of money is correct, but the proper point in public finance is that all operating expenses should be covered by current year revenue. If you can't do that, you have serious problems, and taking on debt to cover some of those expenses is not a solution, its more akin to fraud. If you have decent people running your finance department who won't allow you to paper over your structural issues, you'll be able to catch the problems early and make the necessary changes. But you need strict rules about the use of debt, which I guess Providence doesn't have or doesn't want.

Anyway, sidewalk repair is simply an operating expense, and the use of debt is improper. And, for the record, failing to maintain your sidewalks for multiple years does not magically change sidewalk repair into a capital expense, its just a combination of an operating expense and neglect.